How volatility has affected markets lately

Just when we least expected it, volatility came back in a big way at the end of 2018, delivering sharp daily swings across global markets. CMC Markets’ Chris Smith explains.

This trading year started in a very positive recovery mode up with the US market up 13 per cent from Boxing Day lows, with financial shares and tech leading the recovery.

Some of the most beaten-up stocks are finding some buyers as hopes for China-US trade truce increase, but many investors are still wondering whether we’ll retest lows of last year again on weaker growth.

‘Volatility’, the ups and downs of the market, has put a dint into investors’ confidence.

A year of extremes

Last year was all about extremes. Looking back, 2018 will be remembered for Apple becoming the first company to hit

US$1 trillion market capitalisation – but also for producing the worst December market performance since 1931.

Markets hit new highs last year in October, but the S&P500 ended the year with a decline of 6 per cent, its first negative annual total return since 2008.

The popular Dow Jones Index closed 2018 down 13 per cent from its highs of the year and saw volatility that investors and traders hadn’t seen since February 2018. It moved 1000 points on five different trading days.

Expect rises and falls

It’s normal for stock markets to rise and fall. They’re cyclical, but often seem irrational, due to herd behaviour, partly driven by the media.

When volatility is high, traders who are more short-term in nature might want to adjust the size of their positions and make sure they have risk-management orders in place.

A recent survey conducted by Colmar Brunton with the New Zealand Stock Exchange (NZX) showed real estate is still the preferred investment for investors in New Zealand, and you can see why.

In the world of property investment, there isn’t anyone telling you what your property’s worth every day. In the stock market, there’s live pricing from minute to minute.

The survey showed that after property, shares were owned by 18 per cent of New Zealanders, and fixed income investments remained popular.

Return to normal?

Volatility in share prices is not abnormal, if you look over history. What’s been more of a shock is the move from the total calm we saw in 2017.

Let’s look at the main US index, the S&P500, and count how many movements there have been of more than 1 per cent up or down in a trading year.

There were only eight in 2017. That’s 3 per cent of the trading days in a calendar year. Compare that to 2018, which ended with a massive 79 days of closing moves over 1 per cent – almost a third of the circa 250 trading days in a year.

This was more ‘extreme’ volatility too – 20 of those days went up or down more than 2 per cent. This didn’t happen at all the year before.

Over the years since 1950, the market has been stable and averaged only around 50 days where the market moved up or down 1 per cent (Figure 1, below).

Knowing this puts volatility into perspective and might help us behave more rationally.

More recently, we saw increased numbers of trading days with 1 per cent-plus moves. In 2015, there were 19 per cent, and in 2016, 28 per cent, which was more in line with last year.

Media headlines drive emotion, which can spark people to make short-term decisions.

Power of the tweet

US President Donald Trump’s preferred method of communication is Twitter, which has made it a new, powerful medium for market watchers. News affecting the market could come at any time.

Last year, Trump sent over 3,400 tweets, rising to an average of 12 tweets a day towards the end of the year.

Based on the outlooks of investment banks and commentators, we should expect more of the same, although recent issues can be resolved. There’ll be some big challenges on debt but overall growth should continue, although at a slower pace in the face of rising interest rates and falling consumer demand.

Three of the concerns are China-US trade discussions, central bank tightening globally, and weaker global growth, which could lead to a recession and corporate debt concerns.

However, the US is the main engine of world markets, and it’s seeing some positive growth figures. There’s economic data that may well help the markets’ recovery and it could rise further in 2019 as valuations became attractive again.

Bear (downward) market moves are scary and need to be respected, but they can make way for the next cyclical bull (upwards) market.

Definitions

Standard & Poor’s 500 Index (S&P 500): A market capitalisation weighted index of the 500 largest US publicly traded companies, across all industries, by market value.

Recession: A decline in economic activity, generally defined by a fall in GDP over two successive quarters.

Volatility: Variation, or ups and downs.

Published 26 February 2019

Story by Chris Smith

This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.

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